First half results show gap between Chinese 5G ambition and MNO finances

There has often been a gap between the bold ambitions of China’s government and the commercial realities of its mobile operators, and this has only been intensified by the very public disputes with the USA over 5G, trade and cybersecurity. Against that context, the national pride at stake in ‘winning the 5G race’ has become more important than ever, to both countries, and some of the statements and promises have gone well beyond what is commercially viable for MNOs to deliver.

China’s four 5G licence holders – China Mobile, Telecom and Unicom plus the new mobile entrant, China Broadcasting Network – are state-controlled and so have somewhat different commercial and shareholder responsibilities to their counterparts in the USA. But they do have to report quarterly results and deliver profits and strong value to their shareholders, whether public or private. In 3G, they were very late to the game, partly because the government was keen to foster a homegrown platform, TS-CDMA – in the end, only China Mobile was forced to use this but it damaged that MNO’s business for some years and prompted it to move rapidly to 4G in order to escape its imposed dead end.

In 4G, the roll-out started later than many around the world but was rapid and massively expensive, driven by the MNOs’ need to catch up with other countries in terms of meeting rising consumer demand; and also by grand government plans for digital and mobile transformation.

Yet the operators struggled to turn all this enthusiasm and investment into commercial success. In the first quarter of 2015, for instance, China Mobile reported a 5.6% year-on-year fall in net profit (to CNY23.8bn or $3.84bn), its seventh sequential quarterly decline, as a result of heavy spending on 4G build-out and marketing. Revenue was up 3.9% year-on-year to CNY160.9bn ($25.9bn).

Yet the operator had met so many KPIs – its massive TD-LTE roll-out saw 53m 4G customers added during the quarter, up more than 50%. This helped clock up record net adds in the period, and took the 4G base to 143m, out of a total of 815m subscribers in all (and in shooting distance of the total of 234.7m on Mobile’s unloved TD-SCDMA 3G network). All these users drove mobile data traffic up by 158% on the year-ago period.

But none of that has transformed into sustained profit improvement – in early 2015, indeed, ARPU fell (from $10 to $9.50), which was never meant to happen after a major upgrade to 4G. For the first time, operators were having to invest in major upgrades just to keep up with consumer expectations, not to change them, as users were increasingly measuring mobile broadband against WiFi, in terms of cost and data rates, and finding insufficient difference to justify a 4G premium.

Now the pattern is repeating itself in 5G. When the four Chinese companies were awarded 5G licences in June, the unexpected timing – and accompanying grand statements of intent by the government – seemed to relate directly to the escalating wars of words and tariffs, with the USA. Verizon and AT&T may have led the way in deploying commercial 5G, but the Chinese players would soon overtake them in scale and reach.

But there is a huge cost to deploying another hi-tech, nationwide network, hard on the heels of a massive 4G roll-out which kept the mobile vendors afloat during the most recent recession. Some economists estimate the cost of China’s 5G plan, if the government’s targets for coverage and service quality are met, at over $400bn. Analysts at China-based CCID said the density of the planned 5G network would boost costs to as much as three times more than 4G; while the government’s telecom research unit, the China Academy of Information and Communications Technology estimates total 5G investment might reach CNY2.8 trillion ($411bn) in the period from 2020 to 2030.

That would be equivalent to spending the entire telecoms capex budget for 2018 – which was CNY287bn ($40.8bn) – on 5G alone, every year for a decade.

Equities firm Jefferies expects a spike in telecoms capex to about CNY376bn ($53.4bn) from 2021, but even so, these estimates imply that 5G will use up most available funds, with other areas of investment losing out.

China Mobile has, it is true, said it will stagger its 5G investment over a decade, rather than just 3-4 years as in 4G; and the three operators will benefit from greater sharing of passive infrastructure – and possibly transport networks and some active equipment – via the state-mandated joint venture, China Towers, the largest tower operator in the world. And the operators are supported by their government in one very important way, which contrasts with the situation for US, Indian and European MNOs – spectrum is awarded without significant upfront costs.

This is not even on a beauty contest basis, as in some Asian and Nordic nations. Spectrum is allocated quite generously in terms of quantity, but with rigid mandates in terms of build-out. This reduces the operators’ upfront costs, but limits their commercial flexibility to align build-out with demand, and sometimes lumbers them with unrealistic demands.

And the operators’ most recent quarterly results show them to be in no state to make that investment of $400bn over the coming years, without significantly more time to achieve return, and flexibility in terms of setting their roll-out priorities.

China Mobile suffered its first half-year decline in both revenue and profit for a decade and saw its share value drop by 10% on the news. The stock has declined by 15% this year.

Yet investment demands remain unchanged. The MNO said, on an analyst call to discuss its latest results, that it would invest CNY17.2bn ($2.4bn) in 5G this year, a similar figure that it stated in 2018. However, it warned that, in order to stick to its capex target, it would have to reduce spending on some other areas.

The largest MNO has pledged to deploy between 30,000 and 50,000 5G base stations in 2019, with a commercial launch in 50 cities in the fourth quarter. As for its smaller competitors, China Telecom will invest CNY9bn ($1.3bn) in building 20,000 5G base stations in 40 or more cities in the same timeframe, while China Unicom will spend CNY6bn-8bn ($0.85-$1.1bn) to build 20,000 base stations.

The cost challenges of meeting both consumer and national demands for 5G come at a bad time for the MNOs. They are in the midst of a period of slow growth, and this is worsened by increased competition from the new 5G entrant and from MVNOs (see separate item), plus government measures to drive down mobile data charges and so stimulate usage and the wider mobile-enabled economy.

As a result of a long-running policy to reduce fees, China now has the lowest mobile data rates of any major market at between 3 and 17 US cents per month per GB. Adjusting for per capita income, that compares with rates of 24 cents in Japan and 22 cents in the USA, according to Jefferies. The firm’s analyst Edison Lee said the US sanction on Huawei, and more general trade wars with China, may force the latter country to scale back its ambitions somewhat. But that could come as part of a wider recession, and have a knock-on effect on vendors and the 5G industry worldwide.

He write in a client note that a reduction in China’s 5G roll-out program “will mean more hope of lower capex for the Chinese telcos but will spell more downside risk for global communications tech supply chain. This could significantly set back the 5G roll-out timetable of China and also globally.”

China Unicom boosts profits despite falling revenue:

China Unicom suffered from the price pressures imposed by government policies in the first half of 2019. Mobile service revenue was hit by mandated measures to accelerate upgrade cycles and cut data fees, and it fell 6.6% year-on-year for the first six months, to CNY78.7bn, with data sales decreasing 4.7% to CNY51.3 billon and voice revenue falling 16.9% to CNY15.4bn.

Overall revenue fell by 2.8% to CNY144.9bn.

Unlike its larger rival, it managed to boost profits, by 16% year-on-year to CNY6.88bn ($980m). Chairman and CEO Wang Xiaochu said in a statement that Unicom had done this by avoiding “simple price competition” and concentrating instead on “Internet-oriented transformation of products, channels and marketing …with the aim to attaining high quality sustainable growth”.

Unicom is undergoing transformation following the radical step, backed by the government in 2017, of rescuing a ailing telco by encouraging webscale and industrial players to invest in the company. Companies like Baidu, Tencent and some manufacturers took part, and in return, get to shape the strategy for Unicom’s 5G build-out, and ensure high quality networks are prioritized to support and expand their own services and mobile-first initiatives.

In the first half, apex reached CNY22bn, with 58% allocated to mobile networks. The 2019 budget is set at CNY58bn.

To improve coverage in rural areas, the operator said it increased the number of 4G base stations by 180,000 to 1.35m. In addition, it ended June with 200,000 NB-IoT base stations.

China’s operators are not alone in seeing rapid 5G roll-out as a mixed blessing – something that will boost mobile usage and market share, not to mention national pride, but will hit profitability for years to come.

In South Korea, whose operators have experienced the most rapid uptake of 5G services among the world’s early deployers, profits have slumped at both SK Telecom and KT, both of which announced second quarter results recently.

Market leader SK Telecom expects to have more than 2m 5G customers on its network by the end of the year. But the price is high. For Q2, operating revenues rose by 6.8% year-on-year, to KRW4.4 trillion ($3.62bn), with the mobile division recording its first quarter-on-quarter growth for more than a year. “Greater data usage and higher ARPU as a result of 5G launch led to MNO turnaround,” said the operator in a statement.

But operating costs rose more quickly than revenues because of 5G – by 8.1%, to KRW4.1 trillion ($3.37bn), because of marketing and other 5G expenditure. That meant that operating income fell, by 6.9% year-on-year to KRW322.8bn ($270m).

KT’s share price has dropped by 12.5% since December 11 2018 and SK Telecom’s share price has fallen by 15.5% since November 30, amid investor concerns that the revenue boost from 5G will be short term only, while costs will continue to rise as the network is densified.

At KT, operating income for the second quarter fell by 27.8% year-on-year, to KRW288.2bn ($240m), despite a 1.7% rise in service revenues, to KRW5.09 trillion ($4.18bn), and 5% growth in total revenues, to KRW6.1bn ($5.01bn). E

But costs, led by those for 5G sales and marketing, were up 7.4%, to more than KRW5.8 trillion ($4.77bn).

As with 4G in developed economies, operators are pressurized to roll out new services early or risk losing ground to more aggressive rivals. They can certainly improve customer retention and acquisition KPIs with a new network and services, and boost usage. The problem comes with charging more for the new generation of connectivity, compared to the last. A few MNOs enjoyed a brief period of premium pricing when they were first to market with 4G – EE in the UK, for instance.

But others had no premium at all, and the same is seen in 5G. Many early movers are pricing 5G the same as 4G and relying on consumers moving to more expensive data plans to support new applications such as advanced video, but amid the return of unlimited data deals, even that well-worn tactic is challenged. Some are experimenting with new ways to assess quality of service, and therefore cost levels – Vodafone Spain is one of a handful of MNOs which are offering 5G plans based on average speed rather than data quantities.

In Korea, there is plenty of growth to chase but no guarantee that will boost revenues. Despite signing up over half a million 5G users apiece within a few months, ARPUs have scarcely risen – SK Telecom’s monthly ARPU was up 0.4% in Q2 compared to the 5G-free Q1, and it was down 4.7% year-on-year because of price competition and government pressures to reduce tariffs. It now stands at KRW30,755 ($25.30), thanks to “higher data usage and the launch of 5G services”.

Only 1.9% of KT’s mobile subscribers were on 5G at the end of June, the firm said, which means it has about 21m subscribers to convert. SK Telecom has 530,000 5G customers in a total mobile base of about 24m. But it is usually the early adopters which use the most data and are most willing to pay for something new.